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David McLaughry, FCAS, MAAA CAS Special Interest Seminar, Chicago, IL October 1, 2013


  1. ������������������� ������������������������������ David McLaughry, FCAS, MAAA CAS Special Interest Seminar, Chicago, IL October 1, 2013 �������������������������������������������� ����������������� • The Casualty Actuarial Society is committed to adhering strictly to the letter and spirit of the antitrust laws. Seminars conducted under the auspices of the CAS are designed solely to provide a forum for the expression of various points of view on topics described in the programs or agendas for such meetings. • Under no circumstances shall CAS seminars be used as a means for competing companies or firms to reach any understanding—expressed or implied—that restricts competition or in any way impairs the ability of members to exercise independent business judgment regarding matters affecting competition. • It is the responsibility of all seminar participants to be aware of antitrust regulations, to prevent any written or verbal discussions that appear to violate these laws, and to adhere in every respect to the CAS antitrust compliance policy. 2 ��������������������������������������������� ������� • Overview of Mortgage Guaranty Insurance (“MI”). • Brief history of MI. • How the industry has fared since 1980. • What went wrong? • Fallout from the crisis. 3 ��������������������������������������������� 1

  2. ��������������������������� BORROWERS LENDERS MI Premium MI Premium MI PROVIDER High-LTV Mortgage MI Coverage Lenders or Borrowers pay MI Banks provide high-LTV Mortgage Insurer premium for MI coverage, loans. MI is required for provides coverage typically on loans exceeding >80% LTV loans to be against borrower default. 80% LTV. sold to Freddie Mac and Fannie Mae. Mortgage Insurance… Mortgage Insurance benefits… • Provides a form of credit risk transfer to protect financial Benefits the Borrower institutions, allowing financial institutions to offer high-LTV • Purchase home with lower down payment. residential mortgages. • Afford a larger home. • It does not insure the borrower. • Increase home ownership rate. • It insures the financial institution’s loss due to borrower default. Benefits the Lender • Reduces credit risk exposure. • Covers mortgage loans with LTV ratios higher than 80%. • Provides independent secondary underwriting review. • Expands mortgage markets. • Aims to provide stability and soundness to the housing financing system. 4 ��������������������������������������������� ���������������������������� • The policy insures a lender—who may pass the premium cost directly to the borrower—against borrower default on a mortgage loan. • Coverage spans the life of a loan and is generally cancellable only under the following circumstances: • MI premium is not paid. • The loan amortizes below an LTV of 78%, under the Homeowners Protection Act (HPA). • The loan prepays completely. • Insurers provide proportional coverage in the U.S. • Insured risk amount (“risk”) = (loan amount) x (coverage percentage). • To settle a claim, the insurer chooses from three options: • Approve a short sale of the property and pay remaining deficiency. • Purchase the property for the balance due and sell the property. • Pay “optional” settlement equal to (coverage percentage) x (loan amount) + (covered fees). • The claim payment is made to the investor. 5 ��������������������������������������������� �������������������� ��������� ����� $100,000 $90,000 Typically, 25% private MI coverage is provided on a 90% LTV loan. $80,000 ($90,000 X .25 = $22,500) $70,000 $60,000 $50,000 $40,000 Fannie Mae / Freddie Mac layer (the lender may also hold the loan $30,000 in its portfolio). $20,000 $10,000 $- Fannie/Freddie RMBS Fannie/Freddie Mortgage Insurance Down Payment 6 ��������������������������������������������� 2

  3. ���������� • The policy premium can be paid by the lender or can be passed through to the borrower—in the U.S., borrower-paid MI is the predominant form of insurance. • Several premium payment options are typically available. • Single premium. • Annual installment, based upon original or declining balance. • Monthly installment, based upon original or declining balance. • Split premium, a hybrid premium type in which the up-front rate is typically higher than the installment rate. • Single premiums are earned based on a prescribed earnings pattern. • Installment premiums are typically earned over the installment period. • Installment premiums cannot be changed once the policy is written. 7 ��������������������������������������������� ���������������������� • Loss reserves are established at the date of the first missed payment (the “Accident Date”). • Servicers typically report delinquent loans to the MI provider after a loan has been delinquent for 60 days. • Given the length of time it takes to complete the foreclosure process, it typically takes 1.5–2.0 years before a claim payment is made. • The short reporting lag results in much larger reserves for known delinquent loans (“Case Reserves”) than for IBNR delinquent loans. Premium vs Loss Emergence - Monthly Premium Installments • A mismatch of premiums and losses occurs, particularly for installment premiums: Incremental % Emerged Loss Emergence Premium Emergence 0 2 4 6 8 1 0 12 Ag e (Ye a rs) • No explicit reserve for future delinquencies, except if a Premium Deficiency Reserve is indicated. 8 ��������������������������������������������� ���� ���!���"���������"������� • First-lien mortgage insurers are monoline—they insure only first-lien home mortgages. • MI is commercial insurance—customers are financial institutions (banks, credit unions, etc.). • Borrowers are neither a party to nor a beneficiary of the insurance. • Once a mortgage insurer has issued insurance, it can generally only cancel for non-payment of premium. • Cannot re-underwrite at any time during coverage. • The rate / premium charged remains fixed throughout the life of the coverage. • Cannot re-rate during the term of coverage. • The mortgage insurer must maintain a statutory contingency reserve of 50% of earned premium. • If the coverage on the loan exceeds 25%, the mortgage insurer must reinsure any coverage above 25%. 9 ��������������������������������������������� 3

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